Chapter 03 - Securities Markets

CHAPTER 03SECURITIES MARKETS

5.a. The stock is purchased for: 300 x $40 = $12,000

The amount borrowed is $4,000. Therefore, the investor put up equity, or margin, of $8,000.

b. If the share price falls to $30, then the value of the stock falls to $9,000. By the end of the year, the amount of the loan owed to the broker grows to:

$4,000 x 1.08 = $4,320Therefore, the remaining margin in the investor’s account is:$9,000 - $4,320 = $4,680The percentage margin is now: $4,680/$9,000 = 0.52 = 52%Therefore, the investor will not receive a margin call.

c. The rate of return on the investment over the year is:(Ending equity in the account - Initial equity)/Initial equity= ($4,680 - $8,000)/$8,000 = - 0.415=-41.5%

9.a. You buy 200 shares of Telecom for $10,000. These shares increase in

value by 10%, or $1,000. You pay interest of: 0.08 x 5,000 = $400The rate of return will be:

= 0.12 = 12%

b. The value of the 200 shares is 200P. Equity is (200P – $5,000). You will

receive a margin call when:

= 0.30 when P = $35.71 or lower

13. The broker is instructed to attempt to sell your Marriott stock as soon as the Marriott stock trades at a bid price of $20 or less. Here, the broker will attempt to execute, but may not be able to sell at $20, since the bid price is now $19.95. The price at which you sell may be more or less than $20 because the stop-loss becomes a market order to sell at current market prices.

14. a. 55.50

b. 55.25

c. The trade will not be executed because the bid price is lower than the price specified in the limit sell order.

Chapter 03 - Securities Markets

d. The trade will not be executed because the asked price is greater than the price specified in the limit buy order.

11. The total cost of the purchase is: $40 x 500 = $20,000

You borrow $5,000 from your broker, and invest $15,000 of your own funds. Your margin account starts out with net worth of $15,000.

a.i. Net worth increases to: ($44 x 500) – $5,000 = $17,000

Percentage gain = $2,000/$15,000 = 0.1333 = 13.33%

ii. With price unchanged, net worth is unchanged.Percentage gain = zero

iii. Net worth falls to ($36 x 500) – $5,000 = $13,000Percentage gain = (–$2,000/$15,000) = –0.1333 = –13.33%

The relationship between the percentage return and the percentage change in the price of the stock is given by:

% return = % change in price x

= % change in price x 1.333

For example, when the stock price rises from $40 to $44, the percentage change in price is 10%, while the percentage gain for the investor is:

% return = 10% x = 13.33%

b. The value of the 500 shares is 500P. Equity is (500P – $5,000). You will receive a margin call when:

= 0.25 when P = $13.33 or lower

c. The value of the 500 shares is 500P. But now you have borrowed $10,000 instead of $5,000. Therefore, equity is (500P – $10,000). You will receive a margin call when:

= 0.25 when P = $26.67

With less equity in the account, you are far more vulnerable to a margin call.

Chapter 03 - Securities Markets

d. By the end of the year, the amount of the loan owed to the broker grows to:

$5,000 x 1.08 = $5,400

The equity in your account is (500P – $5,400). Initial equity was $15,000. Therefore, your rate of return after one year is as follows:

(i) = 0.1067 = 10.67%

(ii) = –0.0267 = –2.67%

(iii) = –0.1600 = –16.00%

The relationship between the percentage return and the percentage change in the price of Intel is given by:

% return =

For example, when the stock price rises from $40 to $44, the percentage change in price is 10%, while the percentage gain for the investor is:

=10.67%

e. The value of the 500 shares is 500P. Equity is (500P – $5,400). You will receive a margin call when:

= 0.25 when P = $14.40 or lower

16. a. You will not receive a margin call. You borrowed $20,000 and with another $20,000 of your own equity you bought 1,000 shares of Disney at $40 per share. At $35 per share, the market value of the stock is $35,000, your equity is $15,000, and the percentage margin is: $15,000/$35,000 = 42.9%. Your percentage margin exceeds the required maintenance margin.

b. You will receive a margin call when:

Chapter 03 - Securities Markets

= 0.35 when P = $30.77 or lower

17.a. The gain or loss on the short position is: (–500 P)

Invested funds = $15,000Therefore: rate of return = (–500 P)/15,000The rate of return in each of the three scenarios is:(i) rate of return = (–500 $)/$15,000 = –0.1333 = –13.33%(ii) rate of return = (–500 $)/$15,000 = 0%(iii) rate of return = [–500 (–$4)]/$15,000 = +0.1333 = +13.33%

Total assets in the margin account are $20,000 (from the sale of the stock) + $15,000 (the initial margin) = $35,000. Liabilities are 500P. A margin call will be issued when:

= 0.25 when P = $56 or higher

b. With a $1 dividend, the short position must now pay on the borrowed shares: ($1/share 500 shares) = $500. Rate of return is now:

[(–500 P) – 500]/15,000

(i) rate of return =[(–500 $4) – $500]/$15,000 = –0.1667 = –16.67%

(ii) rate of return = [(–500 $0) – $500]/$15,000 = –0.0333 = –3.33%

(iii) rate of return = [(–500) (–$4) – $500]/$15,000 = +0.1000 = +10.00%

Total assets are $35,000, and liabilities are (500P + 500). A margin call will be issued when:

= 0.25 when P = $55.20 or higher